News & Insights

Getting the Most Out of Your Cost of Service & Rate Design Study

One of the core principles of municipal utilities is having cost-based rates. A cost of service study is the tool typically used by municipal utilities to ensure that their rates are tied to their costs of providing electricity to their customers. A cost of service study involves analyzing historical expenses and projecting future cash flow needs to arrive at a revenue requirement. The components of the revenue requirement are then functionalized, classified, and allocated to a utility’s various classes to arrive at proposed rates. While a cost of service study can provide updated rates for a utility, it can also do much more if approached properly.

Reducing Costs is Better than Raising Rates

A cost of service study provides the opportunity for management to take a step back from the day-to-day activities of running a utility and engage in a high-level review of the utility’s costs. A consultant is often brought in to perform the cost of service study to provide objective analysis. An outside party can also be independent of local political issues that can surround rate setting. While many consultants can perform analyses and complete spreadsheets to arrive at projected rates, a consultant with deep experience in utility management and operations can also review a utility’s historical costs and identify opportunities potentially lowering the rate for cost reductions and improved efficiencies – increase needed or eliminating it altogether.

Understand the Competitive Landscape

Many utilities have historically enjoyed a monopoly within their service territories. Over the last few decades, however, the paradigm has shifted. Customers have more options when it comes to power. Retail electric competition and distributed generation opportunities have become increasingly popular. When setting rates, utilities need to understand how both their overall rate level charges, energy charges, energy adjustments, etc.) affect customers’ decisions. This analysis is critical in areas with electric competition, but it is also important in exclusive service territory areas, as many businesses review utilities’ rates when deciding where to locate a new facility. Municipal utilities must also understand that comparing rates between utilities can be complex. A neighboring utility might have what appears to be a low energy rate when comparing tariff sheets, but is relatively high once all the rate riders and adjustments are considered. Municipal utilities typically have fewer rate riders compared to investor-owned utilities, so it is important for a utility to educate customers on how to perform an accurate rate comparison.

Utility Costs Change Over Time

The utility industry is going through a period of unprecedented change and transformation. In many cases, these changes are altering the cost structure of a utility, such as increasing transmission costs in many parts of the country. A utility that hasn’t had a cost of service study performed in five to ten years may have rates that are no longer aligned with costs. We recommend that utilities complete a cost of service study every three years to ensure that rates are in line with costs. Even better than periodic studies are dynamic decision-making tools that allow a utility to adapt to changing costs on a regular basis.

Effective Rate Design Can Help Achieve Utility Objectives

Municipal utilities can use rate design to achieve their goals and objectives. For example, the introduction of an electric vehicle (EV) tariff can help spur additional sales and improve load factor. Effective rate design provides appropriate price signals to customers, especially in situations where a utility’s costs vary significantly depending on when energy is consumed. Innovative rate design for commercial and industrial classes can help promote economic development and utility growth objectives.

Technology Is Changing Rate Design

Advances in communication and metering technology are providing more rate setting options for utilities related to rate design, such as time of use rates and potentially even real-time pricing. Utilities must balance their ability to create more advanced rate structures with the need to have understandable rates that do not confuse customers.

Rate Design Is an Art, Not a Science

While cost of service studies and rate design involve a significant amount of quantitative analysis, ultimately, utilities must make good judgments when setting rates to customers. Factors to be considered include the utility’s objectives, its existing rates, the rates of nearby competitors, the level of support the electric utility is providing to the city’s general fund, and how the change in rate components will affect customers at various usage levels within each class.

– David Niles, Vice President, Avant Energy, Inc.

At Avant, we work with utility management and policy makers to develop a good understanding of the cost drivers of a utility. We apply our utility management and operations experience to identify opportunities to reduce those costs. We help clients make informed decisions that support the utility’s overall goals and objectives. Finally, we help clients implement rate changes effectively, including developing effective communications to customers regarding the rate changes.